Business Lines of Credit
Small business owners looking for financing to cover costs of business needs in 2024 will face a tougher credit approval process and less available funding. The main reason for this is the actions by the Federal Reserve to raise interest rates in 2024 and indicating that they may continue to raise rates in 2024.
The Outlook for Business Lines of Credit, Small Business Loans and Business Funding in 2023
Small business owners looking for financing to cover costs of business needs in 2024 will face a tougher credit approval process and less available funding. The main reason for this is the actions by the Federal Reserve to raise interest rates in 2024 and indicating that they may continue to raise rates in 2024.
Since many small businesses rely on personal credit or financing, it is important to note that the November 2022 Federal Reserve Consumer Credit report shows that U.S. consumers have a very high level of indebtedness already. The elevated levels of debt already held by business owners may indicate that high percentage of borrowers may already have reached their borrowing limits.
According to the Fed Small Business Report 2022 companies that did apply for financing were not getting the funds they were seeking.
Additionally, the Fed Small Business Report 2024, says that 66% of firms in their study reported needing additional capital but declined to apply for a loan due to weak financials or though lender requirements were too strict.
Why A Business Line of Credit May Be a Good Option in 2023
So what is a business line of credit? And, how does it differ from a conventional loan? Funding options for small businesses can get very specialized. Learning how to use a business line of credit can be a life-line for a small business and may even be the difference between success and failure.
In a rising interest rate environment, borrowing money has a higher costs. Business owners will want to optimize their borrowing to reduce borrowing costs. With a business line of credit, the business owner can draw down funds as needed and pay interest only on the balance used (up to the limit), thereby optimizing borrowing costs.
Get a Business Line of Credit for your Business
Business Financing Options: How Does a Business Line of Credit Work?
A small business line of credit, sometimes referred to as an “BLOC”, is similar to a business credit card or revolving line of credit in some ways. It allows a business owner to establish a pre-determined amount of funding (borrowing amount), or credit limit to draw funds when needed. So, it functions like ready cash.
A BLOC can be used for any business expenses. This is different from a conventional loan where the borrower receives all the borrowed amounts in one lump sum. With a business line of credit, the borrower takes whatever amounts needed (up to the pre-established credit limit).
Using a line of credit, the borrower only pays interest on the outstanding amounts borrowed, avoiding interest payments on the amount that are not used immediately. Once established, drawing funds is quick (usually as easy as writing a check).
This will give a business owner an assurance of credit availability, as it guarantees cash on hand whenever necessary. This is particularly useful to cover any unexpected expenses in your business. It can be used for anything from repairs to the purchase of new equipment, to making new hires. If you have time gaps between capital needs and revenue realization, a line of credit can help you ride out the cycle until accounts receivable have been collected.
What are the best places to get a Small Business Line of Credit?
Line of Credit Application Checklist
- Business Bank Account – Most lenders require that you have a business checking account (separate from your personal bank account.
- Bank Statements – Most lenders will want you to prepare at least one year of bank statements.
- Understand your needs and amount of credit you need. Just keep in mind that a LOC is a shorter-term type of loans and so the loan amounts are generally lower than conventional term loans.
- When do you need the loan? Plan ahead, get a line of credit before you need one
- Check the approval guidelines before applying or use an online lender to help understand your credit profile. Your bank is usually the best place to go for a LOC if you have a long, solid history. However, if you have less-than-perfect credit, are a startup or new business you may wish to explore your options. Remember, each time a lender does an inquiry against your credit report; it can weaken your credit.
- As with any type of small business loan options, know the cost of borrowing. Always compare APR, origination fees and other features. Are there prepayment penalties, draw fees, maintenance fees or annual fees? This is where online lenders can give you an advantage. Once again, if you have a good relationship with your bank, try them first; chances are you will get your best deal with your own bank for qualifying applicants.
Unsecured Small Business Lines of Credit: Traditional Banks vs. Online Lenders – What is the Difference?
This one gets a bit confusing for some; mainly because almost every bank has a web site where you can apply for a small business loan or line of credit. Every financial institution appears to be an “online lender” these days. However, traditional lenders such as banks have different requirements, regulations and standards versus online lenders. As a rule of thumb (but not always), banks will have more strict lending criteria and offer the lowest rates on borrowing and online lenders will have lower requirements and offer slightly higher borrowing costs.
Unsecured Small Business Line of Credit with Traditional Banks
We have already discussed some of the main differences between banks and online lenders in granting access to lines of credit to your small business. Now, let’s explore some of the nuances and what to expect when applying for a LOC at your bank.
Consolidating all financial activities
So you have been granted a conditional approval at your bank for an attractive line of credit for your business, great; but what are the conditions? Banks may require your small business to consolidate all your financial activities with that bank. This will include checking and payroll accounts, operating accounts, etc. Not only will the bank make more profits by compelling you to do all your banking with them, it’s also a way to monitor the health of your business, track annual revenues and monitor your business expenses.
LOC Loan Amounts and Limits
Banks will generally establish credit lines for small businesses starting at $10,000 (many have a $25,000 minimum), up to $100,000. Of course this is a general rule and banks may offer higher limits, but there are generally a small percentage of borrowers who qualify for the higher LOC amounts.
Cost of Borrowing
Interest rates on lines of credit can vary greatly depending on your credit history; with many banks offering rates as low as Prime +1.75%. The stronger your credit profile, the better chances that you will receive lower interest rates, thus lowering monthly payments. Conversely, a weaker credit score will subject your business to higher interest rates and more stringent repayment terms.
Collateral requirements
In many cases banks will grant near minimum limits for an unsecured LOC unless the company and applicant have outstanding credit profiles. Reading the small print shows the extent and possible limitations at a glance. Higher limit LOC’s without an exceptional credit profile will usually require some type of hard-asset collateral, despite it being an “unsecured line”.
Traditional Bank Loan Application Process
Surprisingly, applying for a small business line of credit at a traditional lending institution such as a bank is done on paper. Many banks, even larger institutions have not yet digitized their lending operations. This usually translates into lengthy application and approval processes.
Unsecured Small Business Line of Credit with an Online Lender
Originally referred to as alternative lenders, online lenders have become competitive sources of small business financing, especially in the popular area of small business line of credit products. Online lenders were originally alternatives to big banks. During the financial crisis, the big banks virtually stopped lending to small business despite getting billions of dollars in government assistance and government-backed guarantees to do so. To fill the need left by the large banks neglect of the small business lending marketplace, an entire industry of online lenders emerged to fill the void.
Requirements
To qualify for a commercial line of credit, especially an unsecured business line of credit from an online lender, you’ll typically need to show that you have:
Credit score 680+
Have an active business bank account
Up to 3 years of tax returns and financial statements
12 months in business
$20,000 in average monthly revenues
Ability to pledge short-term assets (like accounts receivable)
No recent bankruptcies, foreclosures, or tax liens
In some cases, a personal guarantee may be required
Loan Limits
Online lenders make extensive use of technology to manage underwriting decisions. In addition, they will require access to your electronic banking data to make near real-time assessments of your creditworthiness. This allows the lender to automatically adjust the lending limits accordingly. This may at first seem obtrusive to a small business owner, but it actually provides solid feedback to the business owner about their business and finances. However, most loans for LOC’s are similar to traditional banks between $10,000-$100,000.
Cost of Borrowing with online lenders
APR’s tend to be slightly higher with online lenders on average. Mainly, this is due to the fact that online lenders tend to be lenders of last resort for borrowers who have marginal credit and have been turned-down by traditional banks; therefore, they are lending to businesses with higher credit risk than banks will tolerate. To offset the higher risk, online lenders may have higher APR’s and sometimes additional fees.
Collateral Requirements
Online lenders may indeed ask for hard asset collateral pledges, but more often they will go a step further and ask for a comprehensive lien on all business assets. This is known a secured line of credit. The extent to which an online lender encumbers the borrower’s assets will be determined by the borrower’s credit rating.
If the lender requires a blanket lien against assets, this may inhibit the borrower from access to gaining further credit.
When is the Best Time to Apply for a Business Line of Credit?
Knowing a few simple tips can mean the difference in costs of borrowing, and the amount of capital you can borrow.
When you have a strong credit rating – If you know your credit rating (your personal credit score mostly) may go up or down in the next few months, plan accordingly. Most small business lines of credit are reviewed annually. So make your application when you have your best foot forward. You are likely to get a lower rate and better terms with a better credit rating.
When business is strongest – Like credit score, you may wish to apply for your small business line of credit when business in trending up.
Apply before you need it – Most business experts advise small business owners to treat a business line of credit somewhat like an insurance policy or a piece of equipment. Apply for and using a business line of credit before it’s needed will ensure it’s there when you need it.
Build history of repayment in good times – following-up on the above, it may be wise to draw upon your line of credit, even though it’s not necessary and repay it promptly to establish a history. Doing so may also qualify you for increased limits and lower rates.
What You May Not Know About a Small Business Line of Credit
Small business owners should carefully review their business line of credit agreements. Even though you may follow some of the above steps for best practices, be aware that lenders usually have the right to rescind a line of credit at almost any time without notice to the borrower. Or, a lender may reduce the upper limit of the amount you can borrow. Business owners who are presently, or may be facing potential headwinds in on-hand cash, may wish to draw their lines of credit in advance. It may be better to draw the funds if a crisis is looming and accept the cost of interest payments than to endure a cash crisis without means to draw additional capital.
Collateral requirements
In many cases banks will grant near minimum limits for an unsecured LOC unless the company and applicant have outstanding credit profiles. Reading the small print shows the extent and possible limitations at a glance. Higher limit LOC’s without an exceptional credit profile will usually require some type of hard-asset collateral, despite it being an “unsecured line”.
Traditional Bank Loan Application Process
Surprisingly, applying for a small business line of credit at a traditional lending institution such as a bank is done on paper. Many banks, even larger institutions have not yet digitized their lending operations. This usually translates into lengthy application and approval processes.
Unsecured Small Business Line of Credit with an Online Lender
Originally referred to as alternative lenders, online lenders have become competitive sources of small business financing, especially in the popular area of small business line of credit products. Online lenders were originally alternatives to big banks. During the financial crisis, the big banks virtually stopped lending to small business despite getting billions of dollars in government assistance and government-backed guarantees to do so. To fill the need left by the large banks neglect of the small business lending marketplace, an entire industry of online lenders emerged to fill the void.
Requirements
To qualify for a commercial line of credit, especially an unsecured business line of credit from an online lender, you’ll typically need to show that you have:
- Credit score 680+
- Have an active business bank account
- Up to 3 years of tax returns and financial statements
- 12 months in business
- $20,000 in average monthly revenues
- Ability to pledge short-term assets (like accounts receivable)
- No recent bankruptcies, foreclosures, or tax liens
- In some cases, a personal guarantee may be required
Loan Limits
Online lenders make extensive use of technology to manage underwriting decisions. In addition, they will require access to your electronic banking data to make near real-time assessments of your creditworthiness. This allows the lender to automatically adjust the lending limits accordingly. This may at first seem obtrusive to a small business owner, but it actually provides solid feedback to the business owner about their business and finances. However, most loans for LOC’s are similar to traditional banks between $10,000-$100,000.
Cost of Borrowing with online lenders
APR’s tend to be slightly higher with online lenders on average. Mainly, this is due to the fact that online lenders tend to be lenders of last resort for borrowers who have marginal credit and have been turned-down by traditional banks; therefore, they are lending to businesses with higher credit risk than banks will tolerate. To offset the higher risk, online lenders may have higher APR’s and sometimes additional fees.
Collateral Requirements
Online lenders may indeed ask for hard asset collateral pledges, but more often they will go a step further and ask for a comprehensive lien on all business assets. The extent to which an online lender encumbers the borrower’s assets will be determined by the borrower’s credit rating.
If the lender requires a blanket lien against assets, this may inhibit the borrower from access to gaining further credit.
When is the Best Time to Apply for a Business Line of Credit?
Knowing a few simple tips can mean the difference in costs of borrowing, and the amount of capital you can borrow.
- When you have a strong credit rating – If you know your credit rating (your personal credit score mostly) may go up or down in the next few months, plan accordingly. Most small business lines of credit are reviewed annually. So make your application when you have your best foot forward. You are likely to get a lower rate and better terms with a better credit rating.
- When business is strongest – Like credit score, you may wish to apply for your small business line of credit when business in trending up.
- Apply before you need it – Most business experts advise small business owners to treat a business line of credit somewhat like an insurance policy or a piece of equipment. Apply for and using a business line of credit before it’s needed will ensure it’s there when you need it.
- Build history of repayment in good times – following-up on the above, it may be wise to draw upon your line of credit, even though it’s not necessary and repay it promptly to establish a history. Doing so may also qualify you for increased limits and lower rates.
What You May Not Know About a Small Business Line of Credit
Small business owners should carefully review their business line of credit agreements. Even though you may follow some of the above steps for best practices, be aware that lenders usually have the right to rescind a line of credit at almost any time without notice to the borrower. Or, a lender may reduce the upper limit of the amount you can borrow. Business owners who are presently, or may be facing potential headwinds in on-hand cash, may wish to draw their lines of credit in advance. It may be better to draw the funds if a crisis is looming and accept the cost of interest payments than to endure a cash crisis without means to draw additional capital.
Line of Credit Business Resources
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